Topic 6 – Introduction To Macroeconomics
19.a Introduction to Macroeconomics 19.b Output
19.c Macroeconomic Variables 20.a Value Added
20.b GDP
20.c GDP Issues
19.a Macroeconomics
The study of economic aggregates or averages;
the study of how the broad economy behaves.
Includes variables such as total output, total
investment, total exports, price level, and the effect of government policy
MICROECONOMICS = The study of individual (consumer, firm, etc) decisions
MACROECONOMICS = The study of group (industry, country, etc) results
Short Run vs. Long Run
Short Run – study of macroeconomic variables in the short run (when some decisions are
fixed) and how the government impacts these variables
Involves analysis of business cycles
Long Run - study of macroeconomic variables in the long run (when no decision is fixed)
Involves analysis of growth and the impact of
investment and technological change
National Economic Activity is often
summarized by National Product or simply Output
Since wages come from production, National Product = National Income
The are a variety of ways to calculate output, and short-run vs. long-run output reveals
different things about the economy
19.b Output
The current dollar values of all goods
produced in an economy is nominal national income: ∑PQ
This is also called current-dollar national income
This changes when prices or production changes
To ignore the effects of price fluctuations, economics calculate real national income based on prices in a base year: ∑P
baseQ
This is also called constant-dollar national income
This changes when production changes
19.b National Income
Fig. 19-1 Growth and Fluctuations in Real GDP, 1965–2011
(i) The level of real GDP
A common measure of
National Income is Gross
Domestic
Product (GDP)
Long run GDP can show long- term economic growth
Fig. 19-1 Growth and Fluctuations in Real GDP, 1965–2011
Short-run GDP shows the
business cycle – fluctuations of
national income around its trend value
Recession – two consecutive
quarters where GDP falls
(ii) Annual growth rate of real GDP
Real GDP fluctuates around a rising trend:
the trend shows long-run economic growth
the short-run fluctuations show the business cycle
Potential output is what the economy could produce if all resources were employed at their normal levels of utilization.
often called full-employment output
19.b National Income
The Terminology of Business
Cycles
The output gap measures the difference between potential output and actual output.
Output Gap = Y – Y*
When Y < Y*, there is a recessionary gap
The economy’s resources are not fully employed (ie: there is excess unemployment)
When Y > Y*, there is an inflationary gap
The economy’s resources are more than fully employed (ie: there is overtime and extra shifts)
This causes inflation
Output Gap
Fig. 19-2 Potential GDP and the Output Gap, 1985–2011
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(ii) The output gap (i)Potential and actual
GDP
Recession:
There is economic waste and human hardship
(ie: unemployment and low wages; low returns on investment)
Boom:
There is low unemployment and wages are high BUT
Inflation is high and the coming recession will be more severe (plus the average person will be
less prepared for it)
Why Mind The Gap?
19.b – Macro Variables - Unemployment
14.5 Million Canadians covered by Unemployment Insurance in 2008-09
$9.5 billion on regular benefits
$2.9 billion on family benefits (maternity and parental leave)
$1 billion on sickness
$246 million on fishing benefits
$1.6 billion on training, job creation, self-
employment assistance, wage subsidies, and labor market agreements
Unemployment Definitions
There are 3 key categories needed to understand unemployment in Canada:
Employed – adult workers (over 15) who have a job (regardless of hours), are off work due to
illness, vacation, or industrial dispute
Unemployed – workers who were available for work and made an effort to find a job during the previous 4 weeks, or who were available for work and waiting to be recalled from a layoff within 26 weeks, or reporting to a new job within 4 weeks
Unemployment Defintions
Labour Force = Employed +Unemployed
Not in labor force = those who did not have a job and did not actively search for employment (ie:
students, early retired, etc)
% Force 100
Labor
Unemployed Rate
nt
Unemployme
Unemployment in Canada
When Y = Y*, the economy is at FULL EMPLOYMENT
BUT some unemployment exists:
frictional unemployment (natural turnover)
structural unemployment (mismatch between jobs and workers)
Therefore @ full employment,
unemployment ≠0
Unemployment in Canada
When Y < Y*, there is cyclical unemployment
This is caused by the business cycle
Industries with seasonal business cycles (fisheries, parks and recreation, ice cream sales, retailers at Christmas, etc) may have seasonal unemployment
Therefore Statistics Canada publishes seasonally adjusted unemployment values
Fig. 19-3 Labour Force, Employment, and Unemployment, 1960–2011
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(i)Labour force and employment
In general,
employment grows with the labor force
Some frictional and structural
unemployment always exists
Fig. 19-3 Labour Force, Employment, and Unemployment, 1960–2011
(ii) Unemployment rate
Unemployment was highest at 12% during 1982’s depression and lowest at 3.4% in 1966
Excess unemployment represents permanent loss in production;
goods that could supply needs and wants
Unemployment also
causes income hardship
Macro Variables - Productivity
Worked Hours
GDP ty Real
Productivi Labor
Worker GDP ty Real
Productivi Labor
or
Fig. 19-4 Canadian Labour Productivity, 1976–2011
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Real GDP per worker
is measured in thousands of dollars!
Macro Variables - Inflation
Price level: the average level of all prices in the economy.
Inflation: the rate at which the price level is changing.
The CPI (Consumer Price Index) is based on the price of a typical "consumption basket,” relative to the price in
some base year:
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Macro Variables - Inflation
Inflation is the change in average prices from one year to the next:
CPI was 122.2 in April 2012 and 119.8 in April 2013, therefore inflation was:
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% C 100
C Inflation C
1 - t
1 - t t t
PI
PI PI
% 00 . 2
% 8 100
. 119
8 . 119 2
. Inflation
2011-2012122
Fig. 19-5 The Price Level 1960–
2012
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Fig. 19-5 The Inflation
Rate, 1960–
2012
25 Copyright © 2014 Pearson
Canada Inc.
Chapter 19, Slide
Why Inflation Matters?
Inflation reduces the purchasing power of money
$100 buys less once prices go up (inflation occurs)
Inflation adds to economic uncertainty
Individuals make poor decisions if inflation is not what they expected
Ie: A family saves for a house, then it costs more than what they planned
Ie: A firm invests in Argentina, but the currency is worth 10% of what they expected due to inflation
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Inflation Example
Super Savings Bank Account: 2% interest Cash on hand: $100
2 DVD players:
Basic: $100
DVD Playback Deluxe: $102
DVD/VCD/SVCD/AVI/DVD±R/CD/CD±R
3D Blu-Ray, Wi-Fi, Memory Card Slot, Picture
Viewer, Stop Memory, Shiny Red Colour
Inflation Example
You want the deluxe, so you invest for a year, cash on hand in a year: $102
But, due to 3% inflation, the DVD players now cost: $103 (basic) $105.06 (deluxe)
Now you can’t afford either You’ve LOST buying power
Macro Variables- Interest Rates
Interest rates – percentage price paid to borrow money over a period of time
$100 borrowed at 8% interest will cost $8 a year
they show the opportunity cost of a project
Different interest rates apply to different situations
Different interest rates are available to different
people
1.5 Interest Rate Examples (Sept 2011)
Saving:
1 Year GIC: 1%
1 Year Cashable GIC: 0.75%
3 Year GIC: 1.35%
3 Year Cashable GIC: 1.2%
Bank Account: 0.0%
Borrowing
Bank of Canada Rate: 1%
1 year closed Mortgage: 3.5%
1 year open Mortgage: 6.3%
Interest Rate Rules
Bank
of Canada rate for banks(bank rate) (bank rate)
Is less thanBanks’ rates for best customers
(prime rate) (prime rate)
Is less thanTypical Bank Rate
More risk = higher rate
Real vs. Nominal Interest Rate
Nominal Interest Rate:
– Price Paid per dollar borrowed per period of time
Real Interest Rate:
– Nominal Interest Rate adjusted for change
in purchasing power; adjusted for inflation
Calculating real interest
rrrealreal = (1+r = (1+rnomnom))
--- -1--- -1 (1+inf)(1+inf)
rreal= real interest rate
rnom= nominal interest rate inf = inflation
Easy Interest Formula
r
real= (1+r
nom-1-inf)
--- (cross multiply to get…) (1+inf)
r
real+ r
real*inf = r
nom-inf (r
real*inf is small)
r
real= r
nom– inf
DVD player example: r
real= 2%-3%=-1%
Fig. 19-6 Real and Nominal Interest Rates, 1965–
2012
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Interest Rate Importance
Low real interest rates are good for borrowers (ie:
entrepreneurs)
High real interest rates are good for savers (ie:
retirees)
Interest rates affect the level of investing
Topic 7 will investigate how the Bank of Canada influences interest rates
Macro Variables – Exchange Rate
Exchange rate: the number of Canadian dollars required to purchase one unit of foreign currency.
Depreciation of the Canadian dollar means that it is worth
less on the foreign-exchange market (more $Can for $Other)
Appreciation of the Canadian dollar means that it is worth
more on the foreign-exchange market (less $Can for $Other)
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Fig. 19-7 Canadian–U.S. Dollar Exchange Rate, 1970–2012
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Export – Good/service sold to another country
Import – Good/service bought from another country
For Canada, exports and imports are both very large—roughly 35% of GDP—but the trade balance is usually small.
Macro Variables – Export and Imports
Balance Trade
Imports -
Exports
Exports
Net
t t t
Fig. 19-8 Canadian Imports, Exports, and Net Exports, 1970–
2011
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Long Run Growth
Growth is generally positive in the long run
This causes an increase in living standards
Typically gets little media attention
How should the government treat the long-run?
CAN the government affect growth?
Does controlling inflation affect growth?
Does running a deficit cause borrowing and reduce growth?
Should government innovate or allow the private sector to innovate?
Short Run Fluctuations
What causes the business cycle?
Why did the recession hit in 2008?
Why was unemployment so low in 2007?
How much does the Canadian business cycle depend on the US? On Europe? On Asia?
Can the government influence the business cycle?
If so, how much?
20.a Value Added
Production occurs in stages—most firms produce outputs that are other firms' inputs
intermediate goods are used to produce
final goods
Each firm’s contribution to total output (final goods) is its value added
Sum of value added is an economy’s output
i i
i
Goods te
Intermedia of
Cost
Revenue Sales
Added Value
20.b GDP
Three methods for measuring national income (output):
a) total value added from domestic production (good theory, unrealistic in practice)
b) total expenditures on domestic output
c) total income generated by domestic production
Because of the circular flow of income, these three measures yield the same total – GDP
Gross Domestic Product – total value of goods and services produced in the economy during a given period
Fig. 20-1 The Circular Flow of Expenditure and Income
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b) GDP -Expenditure Side
Consider adding up the expenditures needed to purchase the final output produced in any given year.
There are four broad expenditure categories:
consumption
investment
government purchases
net exports
) ( X IM G
I C
GDP
GDP -Expenditure Side
Consumption expenditure (C) includes household expenditure on all final goods during the year
Haircuts, Xbox’s, chicken, legal advice, etc.Haircuts, Xbox’s, chicken, legal advice, etc.
Investment expenditure (I) is expenditure on the production of goods not for present consumption, including:
inventories
plant and equipment (capital stock)
residential housing
Government purchases (G) is the purchase of
currently produced goods and services by government
excluding transfer payments (unemployment insurance, Canada Pension Plan, etc.)
Net exports (X – IM) is the difference between exports and imports
Exports are purchases of Canadian-produced goods and services by foreigners. We subtract imports because they are not produced in
Canada.
Table 20-1 GDP from the Expenditure
Side, 2011
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Chapter 20, Slide
c) GDP from the Income Side
GDP is also the sum of factor incomes and other claims on the value of output.
1) Factor incomes:
wages
rent, interest, and profits
2) Non-factor payments:
indirect taxes (ie GST; income collected but not received)
Subsidies (ie: furnace subsidy; negative tax)
depreciation of existing physical capital
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net domestic income
GDP from the income side is therefore equal to:
GDP = Net domestic income +
Indirect taxes (less subsidies) +
Depreciation
Table 20-2 GDP from the
Income Side, 2011
20.c GDP Issues
1) GDP and GNP
A measure of national output closely related to GDP is Gross National Product (GNP).
GDP measures production in Canada (even if some of the profits leave the country)
Measure of domestic production
GNP measures income of Canadians (even if they earn income outside of Canada)
Measure of domestic income
GNP is typically 3%-4% less than GDP
2) Disposable Personal Income
A more important measure for households is disposable personal income – the part of GNP that households can spend or save
It equals GNP minus:
any part not actually paid to households
Taxes, depreciation, retained earnings, and interest paid to institutions
plus transfer payments received by households
Child Tax Credit, Unemployment Insurance, GST rebate, etc.
20.c GDP Issues
3) The Problem with Nominal GDP
Assume: prices quadruple (x4) production is cut in half (x 1/2) Nominal GDP (year 1) = 1 X 1 = 1 Nominal GDP (year 2) = 0.5 X 4 = 2
although production has been devastated, GDP
reflects extreme growth
Real GDP
-Base year value of all goods currently produced:
∑ quantities X prices
base year-doesn’t change when prices change
-changes when quantities change
The Solution of Real GDP
Assume: prices quadruple (x4) production is cut in half (x 1/2) Real GDP (year 1) = 1 X 1 = 1
Real GDP (year 2) = 0.5 X 1 = 0.5
-real GDP accurately reflects the economy
GDP – Converting Between Real and Nominal
100 GDP x
Real
GDP Nominal
Deflator
GDP
100 Deflator x
GDP
GDP Nominal
GDP
Real
Table 20-3 Nominal and Real GDP in Canada
Note that the CPI and GDP deflator follow different
things:
CPI : price of goods bought by
Canadians
GDP Deflator : price of
goods produced in
Canada
4) Omissions from the GDP
National income accountants cannot measure economic activity
that takes place outside of regular, legal markets:
illegal activities
Leisure (people work less because they derive a benefit from it)
the underground economy (unreported income, trading, etc)
home production (ie: stay at home parents)
economic "bads“ (ie: pollution)
The current calculations is used because:
It would be difficult to correct the major omissions.
The level of GDP may be inaccurate but the change in GDP is a good indication of the changes in economic activity.
To design policies to control inflation it is
necessary to know the ACTUAL, LEGAL flow of money payments made to produce and purchase Canadian output.
Do These Issues Matter?
GDP and Living Standards
"Well-being" is a broader concept than material living standards:
GDP is not a complete measure of economic well-being
Equity, environment, freedom of religion/expression, unemployment, weather, etc are all factors
but income is a very important part of well-being and GDP is a good measure of income.
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Topic 6 Summary
Macroeconomics is the the study of how the broad economy behaves
Long-Run output examines economic growth
Short-Run output gives us the business cycle
The government’s control over each is debatable
Key Macroeconomic Variables include
unemployment, productivity, inflation, interest rates, exports and imports
The difference between real and nominal variables
is key to macroeconomics
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Topic 6 Summary
Only final goods should be considered when calculating a country’s production
Thus every stage of production adds a “value added”
GDP can be calculated from its Expenditure or Income side
GDP is production inside Canada; whereas GNP is income made by Canadians
GDP issues include GNP, disposable income,
nominal GDP problems, and GDP omissions
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